Lesson 18 of 25 · 6 min
Why the index can move daily and the spread almost never does
One leg is repriced by a market that needs nobody's permission; the other requires a person to open a file.
Both legs of the rate can change. They change at frequencies that differ by about two orders of magnitude, and the reason is procedural rather than financial.
The index leg is read, not decided. On each reset date a system pulls the published value of the named index, applies whatever convention the agreement specifies, and writes the result into the accrual engine. Nobody approves it. There is no file, no committee, and nothing to notify, because the agreement already specified that this would happen. Where the reset is daily, that is roughly 252 changes a year.
The spread is a term. Changing it is a repricing: it touches documentation, requires an internal approval, may require a contractual trigger, and in many facilities requires notice. The institution has to want the change enough to pay for the process. So the spread sits still for years and then moves in a single step of fifty or eighty basis points.
The practical consequence is a misattribution that runs in both directions. Nearly all of the rate movement a borrower experiences comes from the leg no one at the institution decided, so a rising rate is rarely a statement about the borrower. And on the rare occasion the spread does move, it is entirely a decision, arriving inside a total rate that may be moving the other way and hiding it.
Key terms
- Reset date
- The date on which the index leg is re-read and applied. Daily in some facilities, monthly or quarterly in others, always stated in the agreement.
- Repricing
- A change to the spread. A documented decision with an approval behind it, in contrast to the mechanical reset of the index leg.
- Pass-through
- A cost moved directly to the borrower without affecting the lender's margin. What the index leg is designed to be.
Worked example
A year of two legs
A facility with a flat $940,000 balance and a daily index reset. Illustrative rates.
- Index at the start and end of the year
- 4.92% to 3.41%
- Index resets applied
- 252
- Spread at the start and end
- 205 bp to 205 bp
- All-in rate, start and end
- 6.97% to 5.46%
- Annualised interest, start and end
- $65,518 to $51,324
- Change in annual cost
- $14,194
Changes: none.
All of it from the index leg.
Two hundred and fifty-two changes moved $14,194 a year. The one number a person could have changed did not move at all.
Check yourself
Over one year the index on a facility falls from 5.16 percent to 4.33 percent, and the lender reprices the spread from 190 to 245 basis points. The balance is $1,375,000. What happened to the all-in rate, and what did the lender's own decision do?
Saved in this browser only. No account, nothing sent anywhere.
Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.